Tags: Detroit | bankruptcy | municipal | bonds

NYT: Detroit Bankruptcy Has Chilling Effect on Muni Bonds

By    |   Monday, 12 Aug 2013 08:06 AM

Detroit's bankruptcy is sending chilling effects through the municipal bond market, and some worry that the situation could get worse, perhaps spreading beyond Michigan.

Cities, counties and local governments throughout the state are already getting a cold shoulder in the municipal bond market, The New York Times reports.

"Detroit's paper is taking it on the chin," Matt Fabian of Municipal Market Advisors told USA Today. But the real test lies in the weeks ahead.

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It remains to be seen whether investors got finicky and sold off municipal bonds beyond Detroit. Or, if investors would start to demand more protection from other municipalities, driving up borrowing costs.

Judgment has been "swift and brutal," according to The Times. Borrowing costs in Michigan have risen, in some cases drastically.

Detroit's situation and it leaders' attitudes are taking on a toll on the investors' perceptions of municipal debt. They've put forth a plan that makes the promise of having the "full faith, credit and taxing power" of a city behind a bond seem a lot less meaningful.

Detroit's state-appointed emergency manager, Kevyn Orr, wants bondholders to take deep cuts and wants all bondholders and retirees to be deemed unsecured creditors, The Times noted. As such, they get sent to the back of the line to hope that some money will trickle down to them after more important debts are paid.

Michigan Gov. Rick Snyder approved Detroit's bankruptcy, but he and Orr claim they are not concerned about the effects on the broader municipal bond market, a level of disregard that critics find disturbing.

According to The Times, three bond sales in Michigan have already been postponed due to the current state of the market. And if Orr's plan goes into effect the situation could get worse.

Critics point to the fact that Detroit's bonds were issued with many different ratings and interest rates. If Detroit lumps them all together, then by logic, the bonds of other Michigan cities should have their ratings changed to reflect that, The Times reported. And as those ratings decline, the bondholders will get hit with losses.

Given the governor's stance, many worry that whatever happens in Detroit will set a precedent for Michigan's future treatment of bondholders. But more importantly, there's concern it could set a national precedent.

Detroit's plan must be approved by a bankruptcy court. If the court approves the proposed treatment of bondholders, other struggling cities may point the federal decision and try to follow suit, The Times stated.

That would have serious implications for borrowing costs, critics warn.

"Depending on the outcome of this, if the [Detroit] bondholders take a haircut, people will look at the [muni bond] market much differently, and want protection," Bill Larkin of Cabot Money Management told USA Today.

But some investors are clinging to the hope of government intervention.

"We bailed out GM. We bailed out the banks. Do we not bail out our own country?" Larkin asked. "At this point, this is something critically important to watch."

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Detroit's bankruptcy is sending chilling effects through the municipal bond market, and some worry that the situation could get worse, perhaps spreading beyond Michigan.
Detroit,bankruptcy,municipal,bonds
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2013-06-12
Monday, 12 Aug 2013 08:06 AM
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